Is so-called smart beta investing a new and improved way to invest or just another one of Wall Street’s fancy sales pitches?
Smart beta strategies (formerly known as “fundamental indexing”) in the investment world generally fall into two camps: 1) Indexes that use a one-dimensional or simple formulas, like equal weighting all the stocks within a benchmark like the Guggenheim S&P 500 Equal Weight ETF (NYSEARCA:RSP) does. Or, 2) Weighting stocks within a portfolio using a multiplicity of complex factors like book value and cash flow, as does the PowerShares FTSE RAFI US 1000 Portfolio (NYSEARCA:PRF).
Although smart-beta pundits attempt to portray their strategies as passive investing, the truth is the strategy resides somewhere between active stock picking and traditional indexing with market cap weighted benchmarks. Either way, smart beta’s goal is to outperform both strategies.
ETFs that weight companies by dividends like the WisdomTree Total Dividend Fund (NYSEARCA:DTD) or by earnings, like the WisdomTree India Earnings Fund (NYSEARCA:EPI) are other offshoots of the smart beta movement, despite their singular focus.
Over the past five years, PRF and RSP have handedly outperformed the S&P 500 (NYSEARCA:VOO) and other cap weighted benchmarks linked to large company stocks.
But even with impressive historical performance by smart beta indexes comes a notable admission.
“Seen from another perspective, the smart beta strategies inherently have value and small size tilts relative to cap-weighted benchmarks,” notes a 2011 paper by Chow, Hsu, Kalesnik and Little.
That acknowledgement shows that smart beta strategies are essentially an old concept but in entirely new packaging. Can’t investors simply tilt their portfolios to overweight small cap (NYSEARCA:IJR) and value stocks (NASDAQ:VLACX), rather than relying on a smart beta ETF to do it for them?
In my latest investing video, I talk with Herb Morgan at Efficient Market Advisors in San Diego, CA about whether smart beta investing is good for investors.